Summary of PRICELINE COM INC

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our financial statements, including the notes to those statements, included elsewhere in this Form 10-K, and the Section entitled "Special Note Regarding Forward-Looking Statements" in this Form 10-K. As discussed in more detail in the
Section entitled "Special Note Regarding Forward-Looking Statements," this discussion contains forward-looking statements which involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause those differences include, but are not limited to, those discussed in "Risk Factors."

Overview

General. We are a leading online travel company that offers our customers a broad range of travel services, including hotel rooms, car rentals, airline tickets, vacation packages, cruises and destination services. In the United States, we offer our customers a unique choice: the ability to purchase travel services in a traditional, price-disclosed manner or the opportunity to use our unique Name Your Own Price® service, which allows our customers to make offers for travel services at discounted prices. Internationally, we offer our customers hotel room reservations in 75 countries and 27 languages.

We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include, among others, the brands Booking.com and Active Hotels in Europe and Agoda in Asia. Our principal goal is to be the leading worldwide online hotel reservation service. At present, we derive substantially all of our revenues from the following sources:

† Transaction revenues from our Name Your Own Price® hotel room, rental car and airline ticket services, as well as our vacation packages service;

† Commissions earned from the sale of price-disclosed hotel rooms, rental cars, cruises and other travel services;

† Customer processing fees charged in connection with the sale of both Name Your Own Price® and price-disclosed hotel rooms and Name Your Own Price® airline tickets and rental car services. We eliminated processing fees for our price-disclosed airline ticket service in June 2007;

† Transaction revenue from our price-disclosed merchant hotel room service;

† Global distribution system ("GDS") reservation booking fees related to both our Name Your Own Price® airline ticket, hotel room and rental car services, and price-disclosed airline tickets and rental car services; and

† Other revenues derived primarily from selling advertising on our websites.

Over the last several years, our business has transitioned from one driven primarily by domestic results to one driven primarily by international results. Prior to 2004, substantially all of our revenues were generated within the United States. In September 2004, we acquired Booking.com Limited, a U.K.-based online hotel service; in July 2005, we acquired Booking.com B.V., a Netherlands-based online hotel service (together with Booking.com Limited, "Booking.com"); and in November 2007, we acquired priceline.com Mauritius Company Limited (formerly known as the Agoda Company, Ltd.), an online hotel service with operations in Singapore and Thailand ("Agoda"). During the year ended December 31, 2008, our international business - the significant majority of which is currently generated by our European operations - represented approximately 58.4% of our gross bookings (an operating and statistical metric referring to the total dollar value, inclusive of all taxes and fees, of all travel services purchased by our customers), and contributed more than two-thirds of our consolidated operating income. Given that our international business is primarily comprised of hotel reservation services, revenue earned

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in connection with the reservation of hotel room nights has come to represent a substantial majority of our gross profit.

Worldwide recession is negatively affecting the broad travel market and, as a result, our business. Most recently, global economic and financial market conditions have worsened markedly, creating uncertainty for consumers and pressuring consumer spending on travel. For example, hotel operators have recently reported significant decreases in occupancy rates (a common metric that measures hotel customer usage) and average daily rates ("ADRs") in both the United States and Europe. We believe that the positive trends impacting our domestic and international business overshadowed these negative influences in 2008. However, market conditions have worsened significantly recently, with particular deterioration in the fourth quarter 2008, and continuing into 2009. We believe worldwide recession and these weakening travel market trends, including, without limitation, decreased consumer demand, further deterioration in ADRs and increases in cancellations, have had a negative impact on our business, particularly in Europe, and will continue to have a negative impact in the near term. We cannot predict the magnitude or duration of this worldwide recession, but our current limited visibility does not suggest any near-term improvement.

The hotel industry has recently experienced a significant decrease in occupancy rates and we have experienced slowing demand growth, an increase in reservation cancellation rates and declining ADRs - trends which have continued to deteriorate and for which we do not anticipate any near-term improvement. While lower occupancy rates have historically resulted in hotel suppliers increasing their distribution of hotel rooms through third-party intermediaries such as us, our remuneration for hotel transactions changes proportionately with room price, and therefore, lower ADRs generally have a negative effect on our hotel business and a negative effect on our gross profit.

We believe the current worldwide recession and lower ADRs are also responsible for the increase in the number of hotel cancellations, particularly at our international operations. Our international operations distribute hotel rooms primarily through an agency model where reservations are generally cancellable, as opposed to merchant models operated by us (principally in the U.S.) and our competition and through which reservations are generally not cancellable without penalty. As ADRs decline, customers who have existing reservations may cancel those reservations and rebook at a lower rate, and in times of economic stress, travelers are more likely to cancel their vacation plans outright. While decreasing ADRs and a worldwide recession make it relatively more attractive for consumers to make a cancellable agency reservation than a pre-paid reservation, our agency business will likely have higher cancellation rates compared to companies who offer predominantly merchant model hotel rooms.

International Trends. The size of the travel market outside of the United States is substantially greater than that within the United States. Historically, Internet adoption rates and e-commerce adoption rates of international consumers have trailed those of the United States. However, international consumers are rapidly moving to online means for purchasing travel. Accordingly, recent international online travel growth rates have substantially exceeded, and are expected to continue to exceed, the growth rates within the United States. In addition, the base of hotel suppliers in Europe is particularly fragmented compared to that in the United States, where the hotel market is dominated by large hotel chains. We believe online reservation systems like ours may be more appealing to small chains and independent hotels more commonly found outside of the United States. We believe these trends have enabled us to become the top online hotel service provider in Europe, and will allow us to successfully expand our service offerings internationally beyond Europe.

As our international operations have become significant contributors to our results and international hotel bookings have become of increased importance to our earnings, we have seen, and expect to continue to see, changes in certain of our operating expenses and other financial metrics. For example, because our international operations utilize online affiliate and search marketing as the principal means of generating traffic to their websites, our online advertising expense has increased significantly since our acquisition of those companies, a trend we expect to continue in 2009 and beyond. In addition,

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and as discussed in more detail below, since the acquisitions of Booking.com, we have seen the effects of seasonal fluctuations on our operating results change as a result of different revenue recognition policies that apply to our price-disclosed services (including our international hotel service) as compared to our Name Your Own Price® services.

Another impact of the growing importance that our international operations represent to our business is our increased exposure to foreign currency exchange risk. Because we are conducting a significant and growing portion of our business outside the United States and are reporting our results in U.S. dollars, we face exposure to adverse movements in currency exchange rates as the financial results of our international operations are translated from local currency (principally the Euro and the British Pound Sterling) into U.S. dollars upon consolidation. Our international operations contributed approximately $619.8 million to our revenues for the year ended December 31, 2008, which compares to $372.6 million for the year ended December 31, 2007. Approximately $11.3 million of this increase is due to fluctuations in currency exchange rates. As a result, our year-over-year revenue growth in the year ended December 31, 2008, was approximately 63.3% on a local currency basis compared to approximately 66.4% after giving effect to currency fluctuations. The U.S. dollar has generally weakened since we acquired Booking.com B.V. in July 2005, and as a result, the year over year growth rates in our international results, when reported in U.S. dollars, have been positively impacted by changes in foreign exchange rates. However, the U.S. dollar has recently strengthened significantly against the Euro and the British Pound Sterling, which results in decreased net assets, revenues, operating expenses, and net income, and in October 2008, for the first time since our acquisition of Booking.com B.V., the foreign exchange impact was negative rather than positive. Accordingly, it will become increasingly difficult for us to grow our gross bookings, revenues and earnings on a U.S. dollar-denominated basis during 2009 and beyond if the U.S. dollar continues to strengthen. If the U.S. dollar weakens against the local currency, the translation of our foreign-currency-denominated balances will result in increased net assets, gross bookings, revenues, operating expenses, and net income. The impact of short-term currency fluctuations on our income for the year ended December 31, 2008 was minimized by certain derivatives we held. As of December 31, 2008, derivatives with a notional value of 25.0 million Euros were outstanding. As of December 31, 2007, derivatives with notional values of 16.0 million Euros and 3.7 million British Pounds Sterling were outstanding. Furthermore, our derivative instruments are not designed to hedge against currency fluctuation that could impact our foreign currency denominated gross bookings.

Domestic Trends. While demand for online travel services continues to experience annualized growth, we believe that the domestic market share of third-party distributors, like priceline.com, has declined over the recent past and that the growth of the domestic online market for travel services has slowed. We believe the decline in market share is attributable, in part, to a concerted initiative by travel suppliers to direct customers to their own websites in an effort to reduce distribution expenses and establish more direct control over their pricing.

In addition, recent decreases in domestic airline capacity and the emerging prospect of industry consolidation, as evidenced by the recent merger agreement between Delta Air Lines and Northwest Airlines, could further reduce the amount of airline tickets available to us. Furthermore, we have recently observed a sharp decline in passenger traffic and airfares across the airline industry, and we believe the airlines are experiencing significant year-over-year declines in yield, all of which we believe is principally due to the worldwide recession. Decreases in capacity and lower traveler demand negatively impact our domestic air business, which in turn has negative repercussions on our domestic hotel and rental car businesses. In addition, the current worldwide recession is partially responsible for a change in the arrangements between rental car companies and automobile manufacturers. Where manufacturers have historically supplied cars to rental car companies under a lease or another arrangement whereby the manufacturer would buy the car back when it is taken out of the fleet, manufacturers have begun to require the rental car companies to purchase the cars for their fleets, which shifts the burden of risk of selling the car to the rental car company. Because of the worldwide recession, rental car companies have struggled to sell such cars, and as a result, they are faced with excess supply. This, along with an intensely competitive environment, leads to lower retail rental car rates, which in turn, are beneficial to

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our retail rental car business, but detrimental to our Name Your Own Price® business. Notwithstanding these trends, we continue to believe that the market for domestic online travel services is an attractive market with continued opportunity for growth.

We also rely on fees paid to us by global distribution systems, or GDSs, for travel bookings made through GDSs for a portion of our gross profit and operating income. Connectivity to a GDS does not guarantee us access to the content of a travel supplier such as an airline or hotel company. We have agreements with a number of suppliers to obtain access to content, and are in continuing discussions with others to obtain similar access. If we were denied access to a suppliers' full content or had to incur service fees in order to access or book such content, our results could suffer.

We believe that our success will depend in large part on our ability to maintain profitability, primarily from our hotel business, to continue to promote the priceline.com brand in the United States, the Booking.com brand internationally, the Agoda brand in Asia and, over time, to offer other travel services and further expand into other international markets. Factors beyond our control, such as worldwide recession, terrorist attacks, political instability, regional hostilities, increases in fuel prices, imposition of taxes or surcharges by regulatory authorities, travel related accidents, travel related health concerns, unusual weather patterns, including natural disasters such as hurricanes, tsunamis or earthquakes; or the withdrawal from our system of a major hotel supplier or airline, could adversely affect our business and results of operations and impair our ability to effectively implement all or some of the initiatives described above. For example, recent civil unrest during the peak booking season in Thailand, a key market for our Agoda business, negatively impacted booking volumes and future civil or political unrest would further disrupt Agoda's business. We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results. We also intend to broaden the scope of our business, and to that end, we explore strategic alternatives from time to time in the form of, among other things, mergers and acquisitions. Our goal is to improve volume and sustain gross margins in an effort to maintain profitability. The uncertain environment described above makes the prediction of future results of operations difficult, and accordingly, we cannot provide assurance that we will sustain revenue growth and profitability.

Seasonality. Our Name Your Own Price® services are generally non-refundable in nature, and accordingly, we recognize travel revenue at the time a booking is generated. However, we recognize revenue generated from our retail hotel services, including our international operations, at the time that the customer checks out of the hotel. As a result, a meaningful amount of retail hotel bookings generated earlier in the year, as customers plan and reserve their spring and summer vacations, will not be recognized as revenue until future quarters. From a cost perspective, however, we expense the substantial majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated. Therefore, as our retail hotel business continues to grow, we expect our quarterly results to become increasingly impacted by these seasonal factors.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are more fully described in Note 2 to our Consolidated Financial Statements. Certain of our accounting policies are particularly important to our financial position and results of operations and require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. On an on-going basis, we evaluate our estimates, including those related to the items described below. Those estimates are based on, among other things, historical experience, terms of existing contracts, our observance of trends in the travel industry and on various other assumptions that we believe to be reasonable under the circumstances. Our actual results may differ from these estimates under different

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assumptions or conditions. A summary of our significant accounting policies that involve significant estimates and judgments of management, including the following:

† Deferred Tax Valuation Allowance. As required by SFAS No. 109, "Accounting for Income Taxes," we periodically evaluate the likelihood of the realization of deferred tax assets, and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future income, the carryforward periods available to us for tax reporting purposes, and other relevant factors. Based upon management's assessment of positive and negative evidence, we recorded non-cash tax benefits in 2007 and 2006 of $47.9 million and $28.1 million, respectively, resulting from a reversal of a portion of our valuation allowance on our deferred tax assets. Despite robust growth in the Company's domestic earnings during 2008, the valuation allowance has not been reduced due to inherent uncertainty and the likely negative potential impact the worldwide recession will have on our future operating results and future realization of our deferred tax assets.

† Stock-Based Compensation. We record stock-based compensation expense over the service period based upon the grant date fair value of equity-based grants. We estimate forfeiture rates in determining the amount of compensation to record. In addition, we record stock-based compensation expense for grants that include a performance contingency based upon the estimated probable outcome at the end of the performance period. We periodically adjust the cumulative stock-based compensation recorded when estimated forfeiture rates are adjusted, or when the probable outcome for performance-based shares is updated based upon changes in facts and circumstances.

† Accounting for State and Local "Hotel Occupancy" Taxes. As discussed in Note 18 to our Consolidated Financial Statements, several jurisdictions have initiated lawsuits against many on-line travel companies, including us, alleging among other things, that sales or hotel occupancy tax is applicable to the differential between the price paid by a customer for our service and the cost of the underlying room. In addition, a number of jurisdictions have initiated audit proceedings against us purportedly to determine whether taxes are owed on this differential or issued assessments claiming that we owe tax on this differential for prior periods. Additional state and local jurisdictions could assert that we are subject to sales or hotel occupancy taxes on this differential and could seek to collect such taxes, either retroactively or prospectively, or both. Historically, we have not collected taxes on this differential. To the extent that any tax authority succeeds in asserting that a tax collection responsibility applies to transactions conducted through the priceline.com service, we might have additional tax exposures. We accrue for legal contingencies where it is probable that a loss has occurred and the amount can be reasonably estimated.

† Allowance for Doubtful Accounts. Because we act as merchant of record in the majority of our transactions, we may be held liable for accepting fraudulent credit cards on our website as well as other payment disputes with our customers. Additionally, we are also held liable for accepting fraudulent credit cards in certain retail transactions when we do not act as merchant of record. Accordingly, we calculate and record an allowance for the resulting credit card charge-backs. In addition, in connection with hotel agency transactions, we provide an allowance for doubtful accounts based on past experience, current trends and the age of commissions receivable.

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† Valuation of Goodwill. We have recorded goodwill related to businesses we have acquired including Booking.com B.V., Booking.com Limited, Travelweb, Agoda and priceline.com europe Ltd. Goodwill is reviewed at least annually for impairment using appropriate valuation techniques. In the event that future circumstances indicate that any portion of our goodwill is impaired, an impairment charge would be recorded.

† Valuation of Long-Lived Assets and Intangibles. We evaluate whether events or circumstances have occurred which indicate that the carrying amounts of long-lived assets and intangibles may be impaired or not recoverable. The significant factors that are considered that could trigger an impairment review include changes in business strategies, market conditions, or the manner of use of an asset; under performance relative to historical or expected future operating results; and negative industry or economic trends. In evaluating an asset for possible impairment, management estimates that asset's future undiscounted cash flows to measure whether the asset is recoverable. If it is determined that the asset is not recoverable, we measure the impairment based on the projected discounted cash flows of the asset over its remaining life.

† Airline Debit Memos. Our airline suppliers periodically send us debit memos that make claims for additional amounts due to them related to the cost of airline tickets we sold on their behalf. We process the debit memos received and, when appropriate, make payments to the airlines. Based on our historical experience and our contractual arrangements with the airlines, we establish reserves for estimated losses when appropriate resulting from these claims.

Recent Accounting Pronouncements - On January 1, 2008, we adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The adoption of SFAS 157 did not have a material impact on our Consolidated Financial Statements. See Note 7 to our Consolidated Financial Statements for more information regarding fair value measurements.

In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, "Effective Date of FASB Statement No. 157" ("FSP FAS 157-2"). FSP FAS 157-2 defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. We do not expect a material impact on our Consolidated Financial Statements for adoption of this Statement for nonfinancial assets and nonfinancial liabilities.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133" ("SFAS 161"). SFAS 161 provides new disclosure requirements for an entity's derivative and hedging activities. SFAS 161 is effective for periods beginning after November 15, 2008. We will comply with the expanded reporting requirements beginning in the first quarter of 2009.

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). In determining the useful life of acquired intangible assets, FSP FAS 142-3 removes the requirement to consider whether an intangible asset can be renewed without substantial cost of material modifications to the existing terms and conditions and, instead, requires an entity to consider its own historical experience in renewing similar arrangements. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and may impact any intangible assets we acquire in future transactions.

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In May 2008, the FASB issued FASB Staff Position No. APB 14-1, "Accounting for Convertible Debt Instruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 requires cash settled convertible debt, such as our convertible senior notes, to be separated into debt and equity components at issuance and a value to be assigned to each. The value assigned to the debt component is the estimated fair value, as of the issuance date, of a similar bond without the conversion feature. The difference between the bond cash proceeds and this estimated fair value, representing the value assigned to the equity component, is recorded as a debt discount and amortized to interest expense over the life of the bond. In addition, if our convertible debt is redeemed or converted prior to maturity and the fair value of the debt component immediately prior to extinguishment is . . .